Wednesday, December 29, 2010

"Molycorp's Cult Status Moves to Options Market" (MCP)

The high-flying rare-earth company is starting to generate strong trading volume among buyers of both puts and calls.Molycorp (ticker: MCP) is becoming a star in the options market.

The rare-earth elements stock is starting to generate strong options trading volume, extending its stock-market darling status into the more nuanced world of puts and calls. Though there are signs of investors hedging the high-flying stock, trading patterns indicate expectations that Molycorp trades higher yet.

Already, Molycorp has gained more than 240% in 2010, defying well-reasoned skeptics who said shares had surged too high, too fast.

Options trading patterns show investors are buying calls, including the January $50 and $55 calls, which increase in value if the $50 stock passes those prices. Investors are also hedging Molycorp in case the strong stock momentum falters. The January $50 put and the February $50 put, for example, have been attracting buyers. Those puts increase in value if the stock falls below $50.

Though there is good reason to hedge the gains of any stock that has more than doubled in value in less than a year, that approach has been a money-losing endeavor in the case of Molycorp. We shared a recommendation from J.P. Morgan to hedge Molycorp in late November that didn't work out as planned. (See The Striking Price, "A Rare Play On Rare Earth," Tuesday, Nov. 23.)

Molycorp's stock defies reason, and gravity. The company's fundamentals do not match the enthusiasm for the rare-earth stock, but that is apparently a minor detail for a company that offers investors a chance to profit from the rare-earth phenomenon.

The company's management knows how to whisper the sweet-nothings investors love to hear.
Last Tuesday, Molycorp announced a joint venture with Japan's Hitachi Metals Ltd. The companies will produce rare-earth alloys and magnets for the computer, health care, communications and alternative energy industries.

Though the deal will be signed in April, investors have already aggressively bid Molycorp's shares higher as the deal suggests Molycorp is becoming a producer of goods, and not just a rare-earth mining company.

The joint venture news follows recent reports that Molycorp would reopen Mountain Pass Mine, one of the world's top rare-earth mine in the 1980s and 1990s that was closed in 2002 because of environmental concerns.

"Stock volume patterns are only modestly positive, but the stock has almost a cult following now," says Larry McMillan, president of McMillan Analysis Corp., a money-management and trading advisory firm.

Indeed, Molycorp's options traded almost three-times average volume on Monday. A total of 25,211 options traded. Most of the volume was calls as 14,642 bullish calls traded, compared to 10,569 bearish puts. The stock gained $4.09 Monday, closing at $45.75, just below its high of $50.29. The stock is trading now at a 52-week high.

Sooner or later, gravity asserts its power over all high-flying stocks, and options, but there is usually ample time to detect trouble. These stocks usually do not crater in one fell swoop, but in a stutter step.
Keep an eye on options volumes for sentiment clues. A sharp rise in put buying would indicate rising bearishness that could be based on expectations of pending news, but for now the trend is your friend.